You don't have to tell Altria Group (MO 1.07%), Reynolds American (RAI), or Lorillard (LO.DL) that electronic cigarettes, or e-cigarettes, are a huge growth opportunity -- the leading U.S. tobacco companies are already jockeying for position in the nascent market.
The e-cigarette market is growing at an astounding rate. Wells Fargo analyst Bonnie Herzog pegs 2013 e-cigarette sales in the U.S. at $2 billion -- triple that of 2012. Moreover, Herzog believes that the e-cigarette market will surpass the $80 billion traditional cigarette market within 10 years.
Given the incredible growth opportunity, it is easy to see why the big tobacco companies are rushing into the market. Lorillard has an early lead; its Blu e-cigarette brand has a dominant 49% market share. Reynolds American's Vuse and Altria's MarkTen e-cigarettes have negligible market share as of yet, but Herzog believes the three companies will have an equal share of the market within the next decade after Reynolds and Altria begin a national push. Altria started its push toward a nationwide e-cigarette roll-out with its recent acquisition of Green Smoke, an e-cigarette business with $40 million in annual revenue, or about 2% market share based on Herzog's 2013 market size estimate.
Investors who are skeptical about the merits of the hysteria surrounding e-cigarettes should take note of the facts below, which suggest the e-cigarette market is about to explode.
Advertising permitted
Among the biggest drags on the traditional cigarette market are the severe advertising restrictions on tobacco products. It is hard to grow a market without being able to place an appealing call to action in front of consumers.
However, the e-cigarette market has virtually no restrictions on advertising thus far. That means there is no Surgeon General's warning taking up half the carton, unrestricted television and magazine advertisements, and celebrity promotions. Lorillard's Blu e-cigarettes feature TV personality Jenny McCarthy, who credits Blu with "restoring her confidence in her dating life."
With unrestricted advertising and celebrity endorsements, the e-cigarette market can get big fast.
No excise taxes
Perhaps the biggest contributor to declining cigarette volumes is high excise taxes, which make up 40% of the price of cigarettes in the United States. The high taxes on traditional cigarettes give e-cigarettes -- which carry only a standard sales tax -- a huge advantage. The annual replacement cartridge costs about $600, much lower than the $1,000+ annual expenditures to consume one pack of traditional cigarettes per day.
Of course, taxing cigarettes is a favorite pastime of state politicians, and e-cigarettes surely will not escape their reach. Herzog forecasts that the average e-cigarette will be taxed at 10% by 2015 and 20% by 2019. Still, that is far lower than the tax on traditional cigarettes, and e-cigarettes will likely enjoy more lax regulation because they are less harmful than traditional cigarettes.
More flavors than Baskin-Robbins
The tobacco industry is licking its chops at the prospect of turning a nicotine- delivery device into a sort of candy. Companies are trying to expand the market potential beyond current smokers by introducing flavored e-cigarettes. Blu e-cigarettes offer Cherry Crush flavor, while another brand offers Cookies & Cream Milkshake-flavored e-cigarettes. Chocolate, watermelon, bubble gum, peanut butter cup, and caramel flavors are also on the market. Consumers can get their nicotine fix and a candy-flavored treat in one product -- with no calories!
The variety of flavors may explain why half of young adults say they would try e-cigarettes if offered one by a friend. This sounds like a marketer's dream and is one more reason why the e-cigarette market is set to take off.
Minors can buy e-cigarettes in some states
Some states have not yet passed legislation regarding the sale of e-cigarettes to minors, meaning teenagers can purchase -- and get hooked on -- candy-flavored nicotine devices. According to the The Wall Street Journal, nearly 2 million middle- and high-school kids used e-cigarettes in 2012. Since fewer young people smoke traditional cigarettes than in the past, tobacco companies desperately need to find a way to create a new generation of nicotine addicts; e-cigarettes are starting to look like the answer.
Positioned as a healthy alternative to traditional cigarettes
In addition to having unrestricted marketing, lower prices, awesome flavors, and strong youth adoption, e-cigarettes are increasingly viewed as a healthier alternative to traditional cigarettes. There is wide speculation that CVS Caremark, which recently announced it would no longer sell tobacco products, will carry e-cigarettes instead as part of its smoking cessation program. If it does, then e-cigarettes would get a major image boost that may make strict regulation less likely.
E-cigarettes appear to be effective smoking-cessation devices. A 2013 Gallup survey discovered that more smokers quit with the help of e-cigarettes than with prescription drugs or nicotine gum. Instead of smoking cigarettes, ex-smokers inhale the less-harmful vapor produced by e-cigarettes, thereby lessening their chances of developing smoking-related illness. If companies can position e-cigarettes as a healthy alternative to traditional cigarettes, the market potential is enormous.
Foolish takeaway
For better or worse, e-cigarettes -- which do not contain tobacco -- are shaping up to be the next big thing in the tobacco industry. Public advocates worry that e-cigarettes will make smoking cool again -- tobacco companies are counting on it. Regardless of the impact on public health, e-cigarettes are a huge opportunity for the tobacco industry -- one that Altria, Lorillard, and Reynolds American are set to dominate in the decades ahead.
